Taiwan-U.S. Double Tax Matters — Finding a Solution

I. Introduction

The “One China” policy, under which the United States recognizes the People’s Republic of China as China’s sole legal government, means that the United States maintains formal relations with China and informal relations with Taiwan. So, while the United States has tax treaties with 12 of its 15 top trading partners, it does not have a tax treaty with its eighth-largest trading partner, Taiwan.¹ Lack of a bilateral tax treaty has often been cited as a barrier for further investment.² Recent supply chain shortages and recognition of the need to strengthen domestic advanced semiconductor manufacturing capabilities have highlighted the necessity of inbound investment by established chipmakers, including those in Taiwan, as well as the need to provide relief from potential double taxation that might arise from cross-border trade and investment.³

This focus on strengthening economic ties led to a bipartisan group of U.S. senators announcing their proposal for a new tax agreement with Taiwan: the Taiwan Tax Agreement Act of 2023.⁴ According to the announcement, the proposal would:

• encourage the president to begin negotiations and encourage the House to work with the Senate on a congressional-executive agreement to establish an income tax agreement between the United States and Taiwan;

• recognize that eliminating double taxation of U.S. and Taiwanese firms could boost bilateral trade and investment, potentially creating new job growth in the United States; and

• encourage the president to seek other ways to increase trade, technology, and investment ties between the United States and Taiwan.⁵

A separate proposal to provide tax relief was introduced in the Senate on October 19, 2023, and an identical bill was simultaneously introduced in the House.⁶ As drafted, the United States-Taiwan Expedited Double-Tax Relief Act proposed to modify the IRC to create section 894A, which would provide certain tax benefits to qualified residents of Taiwan, modeled after the 2016 U.S. model income tax convention.⁷

Thus, by mid-October 2023 there were two competing proposals centered on a common goal of providing tax relief, which varied both in scope and means of implementation.⁸ On November 30, 2023, a combination of the two competing approaches was unanimously approved by the House Ways and Means Committee. This combined approach retains the proposal to provide reciprocal benefits by modifying the IRC and adds Title II, the United States-Taiwan Tax Agreement Authorization Act (Title II Authorization Act),⁹ which authorizes “the President to negotiate and enter into one or more non-self-executing tax agreements . . . to provide for bilateral tax relief with Taiwan beyond that provided for in section 894A . . . and prescribes the process for approving and implementing such an agreement.”¹⁰

H.R. 5988, as approved by the Ways and Means Committee, represents a compromise solution, and was fully endorsed by members of the Senate Foreign Relations Committee (SFRC) and the Senate Finance Committee (SFC). A joint statement by SFC Chair Ron Wyden, D-Ore., and ranking member Mike Crapo, R-Id., as well as SFRC Chair Benjamin L. Cardin, D-Md., says:

We are pleased that the Senate Foreign Relations Committee and the Senate Finance Committee, working with the House Ways and Means Committee, have come to an agreement on this combined legislative package with strong bipartisan and bicameral support.¹¹

This article provides some historical context for this unusual proposal and assesses the merits of the proposals that make up the combined package. Recognizing the need for a practical solution that can provide certainty while being administrable, this article examines some of the issues likely to arise if benefits are provided by modifying the IRC alone without negotiating a tax agreement and concludes with some proposals for navigating this landscape to reach a resolution.¹²

II. Background — The Taiwan Relations Act

Following the 1978 announcement that the United States and China had agreed to establish full diplomatic relations, the United States acknowledged “the Chinese position that there is but one China and Taiwan is part of China.” The Taiwan Relations Act (TRA) was introduced to implement the new U.S. policy,¹³ and it continues to provide a legal basis for unofficial U.S. relations with Taiwan.¹⁴

The American Institute in Taiwan (AIT) was created under the TRA as a nongovernmental organization mandated to carry out U.S. relations with Taiwan.¹⁵ A nonprofit incorporated under the laws of the District of Columbia, the AIT operates with congressional oversight.¹⁶ Under section 6 of the TRA, programs, transactions, and any other relations conducted or carried out by the president or any agency of the U.S. government regarding Taiwan are to be conducted and carried out by or through the AIT.¹⁷ Further, section 6(b) of the TRA provides:

Whenever the President or any agency of the United States Government is authorized or required by or pursuant to the laws of the United States to enter into, perform, enforce, or have in force an agreement or transaction relative to Taiwan, such agreement or transaction shall be entered into, performed, and enforced, in the manner and to the extent directed by the President, by or through the Institute.

Section 12 of the TRA establishes the reporting and approval requirements for any agreements to which the AIT is a party. For example, section 12(c) provides:

Agreements and transactions made or to be made by or through the Institute shall be subject to the same congressional notification, review, and approval requirements and procedures as if such agreements and transactions were made by or through the agency of the United States Government on behalf of which the Institute is acting.

Under section 10(a) of the TRA, the Taipei Economic and Cultural Representative Office in the United States (TECRO) — formerly the Coordination Council for North American Affairs — is the instrumentality with the necessary authority to act on behalf of Taiwan in accordance with the TRA.

The AIT and TECRO have entered into a number of agreements since 1979.¹⁸ A senior Treasury official recently confirmed that negotiations are ongoing regarding a tax information exchange agreement between the United States and Taiwan.¹⁹

III. The Proposals

U.S. lawmakers in 2023 introduced legislative proposals authorizing steps to address tax relief issues relative to Taiwan. On November 30, 2023, the House Ways and Means Committee unanimously approved an amended version of H.R. 5988 by redesignating the Expedited Tax Relief Bill as Title I (“Title I Tax Relief Bill”), and adding Title II, the Authorization Act. Therefore, H.R. 5988 is a compromise between competing proposals that would maintain a proposal to provide certain treaty-like benefits by amending the IRC and, like the Tax Agreement Act by the SFRC, authorize the negotiation of a tax agreement. Each proposal is discussed below.

A. The Title I Tax Relief Bill

The Title I Tax Relief Bill²⁰ of H.R. 5988 is identical to S. 3084, which passed unanimously out of the SFC and was introduced in the Senate on October 19, 2023.²¹ In contrast to the proposal by the SFRC, the Title I Tax Relief Bill would modify the IRC to create section 894A, providing certain tax benefits to qualified residents of Taiwan that are similar to those provided in the 2016 U.S. model tax treaty.

Although the report prepared by the Joint Committee on Taxation describes the rules under the Title I Tax Relief Bill as “analogous to provisions in typical bilateral tax treaties to which the United States is a party and based on the relevant language found in the Model Treaty,” the proposal is unusual in its approach of providing tax relief for certain qualified residents of a foreign jurisdiction by modifying the IRC.²² Unlike a typical tax treaty, the proposal is restricted to a few provisions. For example, the proposal is limited to rules relating to (1) reduced withholding taxes, (2) permanent establishments, (3) the treatment of income from employment, and (4) the determination of qualified residents of Taiwan.

Gross basis withholding tax rates would be reduced from 30 percent to 10 percent for U.S.-source interest and royalties. U.S.-source dividends would be subject to a 15 percent withholding tax rate, but that could be reduced to 10 percent for certain qualified residents of Taiwan meeting holding period and ownership requirements.²³ The Title I Tax Relief Bill employs rules that are analogous to article 5 of a tax treaty for defining a PE, and it provides that a PE is taxable on its taxable income “which is effectively connected with such [PE].”²⁴ Qualified wages paid to a qualified resident of Taiwan are exempt from U.S. tax in certain cases.²⁵ Finally, certain rules akin to the limitation on benefits provisions found in U.S. tax treaties are included to determine whether a person is a qualified resident of Taiwan, and therefore eligible for the benefits of section 894A.²⁶

Understandably, the Title I Tax Relief Bill is limited and does not cover all the provisions typically found in tax treaties because it would propose to grant certain treaty-like benefits solely by modifying the tax code. For example, provisions like the mutual agreement procedure (relating to dispute resolution), exchange of information, and nondiscrimination are not contemplated by Title I. Before any of the rules under the Title I Tax Relief Bill could apply, a determination must be made that there are reciprocal benefits available to U.S. persons subject to income tax in Taiwan.²⁷ Presumably this means that new section 894A would not apply if only some, but not all, of the provisions are reciprocal.

B. Reciprocal Benefits — Some Historical Context

Providing reciprocal benefits to a foreign person by modifying the IRC to reduce or eliminate double taxation as proposed would be unusual, but not unprecedented. In the early 1920s the United States introduced a reciprocal exemption regime in response to concerns that international shipping companies might be subject to double taxation, as well as to encourage international adoption of uniform tax laws affecting these companies. Presumably, the concern was that deriving income from cross-border transportation activities had the potential to create a taxable presence in multiple countries for the shipping company. During that period, former Treasury tax adviser Thomas S. Adams described the difficulty of allocating income and the possibility of double taxation for this industry:

The taxation of a foreign shipping company under a national income-tax law is a particularly difficult thing, as will appear if you stop to think of the problem presented. A tramp steamer comes from abroad and stopping, perhaps only a few days, takes a lucrative cargo from New York, and moves off, perhaps not touching again at the port for eighteen months or more. The allocation of shipping profits to particular ports is intrinsically difficult. . . . By a fortunate movement originating on the part of the United States, the proposal was virtually made to the world that this country would release or exempt the ships of other countries if they took the same attitude towards our own vessels. That reciprocal proposal has been virtually accepted by all the great maritime nations of the world; and today the shipping industry is practically freed from the evil of international double taxation.²⁸

A reciprocal exemption regime was adopted by the United States in the Revenue Act of 1921.²⁹ Under this act, earnings derived by a foreign corporation from the operation of ships documented under the laws of a foreign country would be exempt from U.S. tax if that foreign country granted an equivalent exemption to U.S. corporations. The rule was modified in 1986 to provide an exemption tied to an equivalent exemption provided by the taxpayer’s country of residence.³⁰ In particular, section 883(a) provides that the gross income of a foreign corporation shall not include income derived from the international operation of ships or aircraft if the foreign country where the corporation is organized grants an equivalent exemption to U.S. corporations. There are certain additional requirements that must be met for section 883 to apply. For example, a foreign corporation must determine whether it is organized in a country that provides an equivalent exemption to U.S. corporations and whether its shareholders meet certain requirements.

When reciprocal exemptions were first adopted in the 1920s to resolve issues for the shipping industry, the United States had not concluded an income tax treaty.³¹ In some cases, the granting of an equivalent exemption was confirmed by an exchange of diplomatic notes between the parties. Over time, however, the United States has entered into tax treaties that generally include a “shipping and air transportation” article to address the taxation of profits derived from the operation of ships or aircraft. In most cases in which the United States has exchanged diplomatic notes with a country regarding the equivalent exemption under the IRC, if there is a tax treaty in force with that country, the tax treaty generally also contains a provision on shipping and air transportation.³² The regulations under section 883 recognize the various ways in which an equivalent exemption is granted: (1) the United States has an income tax treaty with the other jurisdiction, (2) the other jurisdiction does not tax the income, or (3) the other jurisdiction provides an exemption under its domestic law. Also, the equivalent exemption may be evidenced by a diplomatic exchange of notes.³³

The Title I Tax Relief Bill similarly states that the provision “shall not apply to any period unless the Secretary has determined that Taiwan has provided benefits to United States persons for such period that are reciprocal to the benefits provided to qualified residents of Taiwan under this section.”³⁴ Also, the bill contemplates that the United States and Taiwan may enter into an agreement or take other necessary and appropriate steps to provide reciprocal benefits.³⁵

Whatever the perceived difficulties and potential for double taxation for the transportation industry by virtue of taxable presence in multiple countries, outside of the transportation industry, bilateral tax treaties rather than reciprocal exemptions have been used for decades to alleviate double tax concerns in the cross-border context. Since 1932³⁶ the United States has entered into almost 70 bilateral tax treaties, and those agreements, unlike the equivalent exemption under section 883 or proposed section 894A, include ancillary provisions that are key to ensuring that benefits may be granted on a bilateral basis.³⁷ Further, the treatment of international transportation income is within the scope of a majority of those agreements. Therefore, it may be possible for taxpayers to claim benefits for this type of income under a tax treaty rather than relying on the reciprocal exemption regime under section 883.

Concerns that the Title I Tax Relief Bill alone is insufficient were expressed at the markup of the bill by the SFC on September 14, 2023. At that time, Sen. Cardin, now the Foreign Relations Committee chair, indicated his support for both H.R. 5988 and the Tax Agreement Act proposed by the SFRC and said that he hoped that both committees could come together with a holistic approach.³⁸ Noting that a tax treaty was not viable, Sen. Cardin stressed the desire to have the predictability of something similar to a tax treaty and indicated that he was open to negotiating an agreement. Similarly, although Sen. Robert Menendez, D-NJ, voted in favor of H.R. 5988, he expressed “deep concerns that this legislation alone is insufficient.”³⁹ Further, Sen. Menendez noted that “our businesses rely on agreements for certainty and dispute resolution that are unattainable through changes to domestic tax law alone.” In response, Wyden committed to working with the SFRC to find a solution.

Over the following couple of months these committees, along with the House Ways and Means Committee, worked together on a compromise proposal that culminated in the chairman’s amendment in the Title I Tax Relief Bill and the Title II Authorization Act.⁴⁰

C. The Title II Authorization Act and Tax Agreement Act

The Title II Authorization Act provides that after a determination by the Treasury secretary that Taiwan has provided benefits to U.S. persons that are reciprocal to benefits provided under section 894A, the president is authorized to negotiate and enter into a tax agreement relative to Taiwan.⁴¹ To the extent that this agreement is negotiated, it must conform with, and may not include elements outside the scope of, customary U.S. bilateral income tax treaties, as exemplified by the 2016 U.S. model tax treaty.⁴²

In that regard, this proposal is identical to the Tax Agreement Act (H.R. 4729; S. 1457)⁴³ as proposed by the SFRC, in which the United States is authorized to enter into a tax agreement with Taiwan through the AIT entering into an agreement with TECRO. In those circumstances, the tax agreement must also conform with the 2016 U.S. model tax treaty. In particular, the Tax Agreement Act specifies that the tax agreement shall:

• apply to qualified residents of the United States or Taiwan;

• provide relief from double taxation; and

• contain measures aimed at limiting the risk of tax evasion or avoidance.

Also, because a tax agreement must conform with customary U.S. tax treaties under either proposal, it’s expected that a tax agreement would include provisions like reduced withholding taxes, rules defining a PE (and the income attributable to it), dispute resolution mechanisms in the form of MAPs, exchange of information procedures, and relief from double taxation. However, the Title II Authorization Act states that no provision of the tax agreement inconsistent with any provision of the IRC shall have effect.⁴⁴ For example, notwithstanding that the 2016 U.S. model tax treaty provides withholding tax rates that are generally lower than those provided in section 894A, it seems that any tax agreement authorized by this legislation must conform with the code, including the withholding tax rates specified in section 894A.

As discussed below, Taiwan also uses bilateral agreements to resolve double tax matters by entering into tax agreements that generally cover the provisions included in a typical tax treaty. Thus, an approach that uses a tax agreement conforming to the 2016 U.S. model tax treaty to resolve double tax matters would be more consistent with the tax policy of Taiwan than the reciprocal benefits approach of the Title I Tax Relief Bill.

IV. Taiwan’s Approach to Relieve Double Tax

The Taiwan income tax system consists of a personal income tax and a business tax on profit-seeking enterprises. A domestic profit-seeking enterprise is subject to corporate income tax at a rate of 20 percent. All profit-seeking enterprises, including subsidiaries of foreign companies incorporated under the Company Law of Taiwan, are considered domestic profit-seeking enterprises. The dividend withholding tax rate is 21 percent for nonresident corporations or nonresident individuals. Generally, the withholding tax rate for interest and royalties is 20 percent (the tax rate for interest from certain financial instruments is 15 percent).⁴⁵

Service fees paid to foreign entities are subject to a 20 percent withholding tax rate in Taiwan unless a reduced rate applies. Under article 25(1) of the Income Tax Act of Taiwan, it may be possible for a foreign company to apply for a deemed profit rate from the tax authority to determine its Taiwan-source income. The deemed profit rate is 10 percent (revenue from international transport activities) or 15 percent (revenue from the other qualified business activities), which would reduce the withholding tax rate from the statutory rate of 20 percent to 3 percent for qualified business activities with a 15 percent deemed profit rate.⁴⁶

Although Taiwan maintains diplomatic relations with only a handful of jurisdictions within the Pacific, Caribbean, and Latin American regions, it has entered into 34 income tax agreements.⁴⁷ According to a recent release by the Department of International Fiscal Affairs in Taiwan, “the Ministry of Finance will continue to initiate the conclusion of income tax agreements with jurisdictions with whom we have close economic and trade relationships and will further refine or simplify the treaty application process so as to create a fair, stable, and reasonable tax environment.”⁴⁸

According to the MOF, its general policy toward income tax agreements is “to eliminate double taxation, prevent tax evasion, improve bilateral investment activities and enhance culture and academic co-operation.” Further, Taiwan has entered into tax agreements based on the OECD and U.N. model treaties and takes “into consideration matters relating to the political and fiscal status, economics, and trade of the mutual parties.”⁴⁹ Taiwan entered its first tax agreement with Singapore in 1981.

Some of the more recent treaties signed are based on the OECD model, considering the contracting parties and their political, fiscal, economic, and trading situations.⁵⁰ For example, in January 2016 Canada and Taiwan entered into the Avoidance of Double Taxation and Prevention of Fiscal Evasion With Respect to Taxes on Income arrangement between the Taipei Economic and Cultural Office in Canada and the Canada Trade Office in Taipei. Canada, like many jurisdictions, has no formal diplomatic ties with Taiwan, but the two maintain de facto embassies in their respective capital cities.

The Canada-Taiwan arrangement includes many provisions reflecting the standard model treaty developed by the OECD. For example, section 5 describes when a PE exists.⁵¹ Also, section 7(1) provides:

The profits of an enterprise of a territory will be taxable only in that territory unless the enterprise carries on business in the other territory through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other territory but only so much of them as is attributable to that permanent establishment.⁵²

Moreover, section 7(2) of the Canada-Taiwan arrangement provides:

Subject to the provisions of paragraph 3, where an enterprise of a territory carries on business in the other territory through a permanent establishment situated therein, there will in each territory be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment and with all other persons.⁵³

Section 24, relating to MAP, provides guidance for taxation not in accordance with the provisions of the Canada-Taiwan arrangement:

Where a person considers that the actions of one or both of the governments of the territories result or will result for that person in taxation not in accordance with the provisions of this Arrangement, that person may, irrespective of the remedies provided by the domestic law of those territories, address to the competent authority of the territory of which that person is a resident an application in writing stating the grounds for claiming the revision of such taxation. To be admissible, the said application must be submitted within three years from the first notification of the action resulting in taxation not in accordance with the provisions of the Arrangement.⁵⁴

The Canada-Taiwan arrangement also includes provisions providing for reduced rates of withholding tax on dividends, interest, and royalties, as well as provisions covering nondiscrimination, methods to eliminate double taxation, and exchange of information. Thus, the tax agreement proposed by the Tax Agreement Act or the Title II Authorization Act would be more consistent with the general policy of Taiwan.

V. Reciprocal Benefits Insufficient by Itself

At the time of this publication, Title I and Title II of H.R. 5988 represent a two-part solution: Tax relief is provided under the IRC, and the president is authorized to enter into a tax agreement relative to Taiwan to provide other benefits, assuming certain requirements are met.⁵⁵ H.R. 5988 is a compromise, heavily negotiated by the taxwriting committees and SFRC, that provides a workable approach compared with the separate, competing proposals released earlier in 2023. There is strong bipartisan and bicameral support, which suggests a high likelihood that the bill will be enacted. However, there are some additional considerations to evaluate in the context of this unusual approach.

A. Is Granting Reciprocal Benefits the Best Approach?

Presumably, as the name might suggest, the Expedited Tax Relief Bill contemplates fast-tracking some treaty-like benefits compared with the time required for a tax agreement to be negotiated and entered into force. Expediting treaty-like benefits is widely seen as an attractive proposition.

The Title I Tax Relief Bill, however, proposes a solution that requires equivalent benefits in the form of a reciprocal exemption, the provenance of which appears to be IRC section 883. That section evolved as a targeted solution to the particular issue of multiple PEs affecting the international transportation industry, which is distinguishable from the double tax concerns that arise more broadly in the context of cross-border trade and investment. Moreover, unlike section 883, the Title I Tax Relief Bill does not propose an exemption from U.S. taxation. Instead, by modifying the IRC, it would impose reduced rates of withholding tax on certain payments available and apply rules regarding jurisdiction to tax based on a PE standard in the tax code.

So far, reduced withholding tax rates and application of PE standards have only been available by operation of a bilateral tax treaty. The United States has a long history of entering into such agreements that, unlike the equivalent exemption under section 883 or proposed section 894A, incorporate decades of experience during which policies have been developed and standards harmonized. Moreover, these uniform principles are generally reflected in model tax treaties. For example, regarding the taxing rights of the residence and source states, source countries generally agree to reduce withholding tax on certain passive income paid to residents of the other country. Further, countries generally agree that the profits of an enterprise are only taxable in its state of residence unless the enterprise has a PE in the other contracting state, in which case only the business profits attributable to the PE may be taxed in the other contracting state.⁵⁶ A key feature of those model tax agreements is that general consensus on some interpretational issues has been developed and is described in model commentary.⁵⁷

These tax agreements also have the capacity to cover other provisions (including relief from double tax, MAPs, nondiscrimination, exchange of information, and so forth) that facilitate arrangements in which governments agree to modify the application of domestic law and provide benefits on a bilateral basis. Without such a formulation or a mandate to enter into a bilateral tax agreement, and because the Title I Tax Relief Bill would grant relief by making modifications to certain provisions of the IRC, it is possible that differences could arise in the interpretation or application of the rules that could affect taxpayers in the United States and Taiwan.⁵⁸

Tax treaties generally include a MAP to provide a mechanism for taxpayers to bring issues that may arise under the treaty to the attention of the competent authorities.⁵⁹ Competent authorities can also clarify issues and resolve cases of double taxation not provided for in the treaty.⁶⁰ Although the Title I Tax Relief Bill authorizes entering into an agreement or taking other necessary steps relative to Taiwan for the reciprocal provision of benefits, as drafted, this authority is limited to providing benefits described in the bill.⁶¹ The Title I Tax Relief Bill by itself does not contemplate any procedures to resolve issues that may arise regarding the operation of the reciprocal benefits regime.

These issues could be resolved if a tax agreement, modeled after the 2016 U.S. model tax treaty, is negotiated and entered into force. The Title II Authorization Act provides a path to accomplish this. Assuming that H.R. 5988 progresses through the legislative process and a two-part solution is adopted, consideration should be given to providing a mandate for the AIT and TECRO to commence negotiating a tax agreement once it’s determined that Taiwan has provided reciprocal benefits to U.S. persons. This way, even if reciprocal benefits are provided under domestic law in the short term, there would be a resolution to move forward with the negotiation of a broader agreement that could incorporate provisions similar to the 2016 U.S. model tax treaty. This would offer a workable comprehensive solution to provide tax relief in a holistic manner. Finally, to avoid a reciprocal benefits regime that relies solely on modifications to the IRC, the Title I Tax Relief Bill should be considered a temporary measure, such that section 894A would sunset once the tax agreement enters into force.

B. Additional Clarifications Would Be Beneficial

To determine whether reciprocal benefits are applicable to U.S. persons, it is necessary to understand and quantify the benefits provided by the United States under section 894A. It is conceivable that confirming reciprocal benefits in the case of reduced withholding taxes for certain items of income (like interest and royalties) would be easily accomplished, assuming that the source of the income is not in question. However, it is unclear how reciprocal benefits in relation to a PE (and profits attributable thereto) would be evaluated.

According to the Title I Tax Relief Bill, section 894A(b)(1) provides that a qualified resident of Taiwan that carries on a trade or business within the United States through a PE shall be taxed on income that is “effectively connected with such permanent establishment.” It is not entirely clear what that phrase means. For example, it may mean that the United States is proposing to apply the “effectively connected” concept of section 864(c), perhaps without limited force of attraction, for profit attribution. Alternatively, it may mean applying the “authorized OECD approach” to determine profits attributable to a PE.⁶² Section 894A(f)(1) only provides that guidance would be issued as necessary to carry out the provision, including regulations. This may mean that regulatory guidance is required to determine if there is a PE in the United States and if the income is effectively connected with that PE.

Also, to determine whether reciprocal benefits are available for qualified U.S. persons, certain areas will require guidance, including how income for services should be taxed. Section 894A does not provide guidance related to payments for services performed outside the United States, presumably because the IRC provides rules regarding taxation of services income.⁶³ To the extent that this income is foreign source, there is no U.S. withholding tax.⁶⁴ In this context, it is unclear how reciprocal benefits for payments received by a U.S. person for services performed in the United States would be evaluated. As discussed, section 894A provides that a qualified resident of Taiwan that carries on a trade or business within the United States through a PE shall be taxed on income that is “effectively connected with such permanent establishment.” There is, however, no reference to a general rule whereby business profits of that person may not be taxed by the United States unless that person carries on a business through a U.S. PE (similar to article 7 of the 2016 U.S. model tax treaty). Thus, to the extent that a U.S. person without a PE in Taiwan receives income for services performed solely in the United States, it would be helpful to clarify that this income should not be subject to withholding tax in Taiwan.

The interaction of the “deemed profit rate” and U.S. rules should also be clarified.⁶⁵ In particular, when the deemed profit rate applies and the generally applicable rate of 20 percent is reduced to 3 percent in Taiwan for the service fees, guidance is needed on the interaction with the U.S. foreign tax credit rules. Further, there should be agreement on the implications, if any, for section 482 and the arm’s-length standard.

Taxation of services income was raised during the markup of H.R. 5988 by the Ways and Means Committee. In a colloquy with ranking member Richard E. Neal, D-Mass., Chair Jason Smith, R-Mo., confirmed that they would work to ensure that the committee report reflects the lawmakers’ intent and clarifies that, when determining if Taiwan has provided reciprocal benefits under the Title I Tax Relief Bill, the Treasury secretary is expected to ensure that Taiwan will not impose tax on the business income of U.S. taxpayers unless the income is effectively connected with a PE of that person in Taiwan.

The committee report was prepared and released in January.⁶⁶ It refers to the “existing asymmetry” in how Taiwan and the United States treat amounts received by residents of one jurisdiction for services performed for residents of the other. In this regard, the report states that “the Committee believes that the reciprocity contemplated in the legislation cannot be confirmed if this disparity in treatment of business income remains.” The Title I Tax Relief Bill does not, however, provide a special rule for services or a rule analogous to article 7 of the 2016 U.S. model tax treaty. Confirmation that Taiwan will not impose tax on the business income of U.S. taxpayers unless the income is effectively connected with a PE in Taiwan could, however, be achieved through a bilateral tax agreement or possibly by a change of domestic law in Taiwan. As discussed, the Title II Authorization Act authorizes the negotiation of a tax agreement, which would be beneficial because it would incorporate guidance like rules relating to PEs, attribution of profits to a PE, and relief from double taxation, all of which would facilitate the operation of the tax agreement as a whole.

C. Tax Coordination Agreement; Alternative to MAP

If a tax agreement is not pursued, presumably a taxpayer will have no recourse to the competent authority to resolve questions related to the application of treaty-like benefits provided under the domestic law of the other jurisdiction. Thus, if a tax agreement as envisaged by the Title II Authorization Act is not pursued, consideration should be given to amending H.R. 5988 (or introducing a companion bill) to authorize the United States to enter into a tax coordination agreement relative to Taiwan. For example, similar tax coordination agreements have been entered into by the IRS and the tax agency of Puerto Rico. These agreements allow the competent authorities to resolve by mutual agreement inconsistent tax treatment by the two jurisdictions.

Coordination agreements generally provide that when, because of differing positions taken by the IRS and the other jurisdiction, a taxpayer is subject to inconsistent tax treatment by the two jurisdictions, designated officials of each jurisdiction must seek to avoid double taxation. Thus, although such an agreement provides a more limited version of the MAP found in a tax treaty, the parties could exchange views to reach agreement on (a) allocating income, deductions, credits, or allowances between related persons; (b) determining residency of a particular taxpayer; and (c) determining the source of particular items of income and allocating and apportionment of expenses.⁶⁷

Entering into a similar agreement relative to Taiwan, in conjunction with providing certain benefits under the Title I Tax Relief Bill, could establish a procedure to resolve certain discrete issues. Although the agreement would be limited in scope compared with a typical tax treaty, it could be a mechanism to facilitate the reciprocal benefits regime. In fact, a tax cooperation agreement would be in addition to other intergovernmental agreements between the AIT and TECRO, like the agreements on mutual legal assistance in criminal matters, cooperation to implement FATCA, as well as shipping and transportation.

VI. Conclusion

Recognizing that a tax treaty is not viable, providing tax relief under the two-part approach proposed by H.R. 5988 appears to be a workable solution. However, because of some of the limitations of providing relief solely under the IRC, consideration should be given to mandating negotiation of a tax agreement once it has been determined that Taiwan has provided reciprocal benefits to U.S. persons, like those provided under section 894A. The benefits of consolidating the two-part approach would be tax relief in the near term, and a bilateral tax agreement that incorporates all the elements necessary to provide a holistic, administrable solution. This result would also be consistent with U.S. and Taiwan tax policy.

Further, while the tax agreement is negotiated, to provide interim guidance on the application of section 894A, consideration should be given to referring to U.S. technical explanations and OECD model commentary to provide interpretative guidance rather than expending resources on issuing regulations, which could take time to issue.⁶⁸ Authorizing a tax coordination agreement to facilitate discussions between the competent authorities should also be considered. Such an agreement could be useful before a tax agreement enters into force, or in lieu of a MAP if a tax agreement is not concluded for some reason. Assuming a tax agreement enters into force, this bilateral agreement could replace all other interim measures.

Should the two-part solution under H.R. 5988 be enacted, benefits could be made available to qualified persons more quickly. Assuming a tax agreement enters into force, other provisions typically found in model treaties that facilitate an intergovernmental tax agreement would eventually be available. This should be advantageous to taxpayers and tax administrations alike. A bilateral tax agreement would establish a common standard with uniform definitions and ancillary provisions facilitating interpretation, including provisions like MAP and exchange of information. History and experience with bilateral tax agreements employing these common standards should be helpful to promote certainty and simplicity. This will leave taxpayers and tax administrations with a system that is more administrable in the long run.